Baird

SARASOTA – The late August rally in the equity markets ran into a stiff headwind in early September as new data show U.S. economic fundamentals deteriorating and the European debt crisis deepening.    The potential for the economy to avoid slipping into negative growth could hinge on Washington’s new proposals to spur job creation and the Federal Reserve’s willingness to initiate another round of quantitative easing.  The stock market’s reluctance to react to the potential for new government actions, however, is due to concern that fiscal stimulus has had limited effectiveness and with10-year Treasury yields already at 2.00% additional Fed easing will have questionable impact. Over the Labor Day weekend European markets were negatively impacted by the ongoing debt crisis.  As a result the S&P futures were down sharply overnight suggesting a full test of the August lows is likely.  It is not unusual for the market to test the lows several times following a selling climax similar to the one experienced on August 8.  It will be important that on any retest that volume and the number of issues hitting new 52-week lows contract. Investors should direct new funds in the current environment to defensive areas of the stock market including utilities, consumer staples and health care.        

Investor psychology grew increasingly pessimistic last week on news the economy is flirting with recession.  The 3-day CBOE equity put/call ratio climbed to 73% from 70% the previous week and is on the verge of triggering a short-term buy signal (58% is considered bearish and 76% bullish).  The 10-day CBOE put/call ratio finished the week at 117%, indicating excessive bearishness (75% is considered bearish and 95% bullish). The latest numbers from the National Association of Active Money Managers shows a drop in equity exposure last week to just 21% (20% is considered bullish and 79% bearish).  The CBOE Volatility Index finished the week near 34 indicating excessive levels of fear in the stock market are present. The latest report from Investors Intelligence (II), which tracks the recommendations of Wall Street letter writers, shows the bulls unchanged at 40.9% from the previous week.  The outright bears among the advisors climbed to 36.6% from 33.3% the previous week and 23.7% two weeks ago. The II service history argues that when the bulls and bears are evenly split the market is typically on the verge of an important rally.  The most recent data from the American Association of Individual Investors (AAII) shows a rise in bulls to 39% from 36% the previous week.  The outright bears in the AAII survey fell to 32% from 41%.  The AAII survey is problematic but is the only area to show a measure of complacency.  Overall the sentiment indicators argue that liquidity is building on the sidelines to support a rally.   

Considering the latest data on jobs, manufacturing, construction and consumer sentiment, the magnitude of the economic decline has only been experienced eight times in the past 40 years; and in seven of those cases a recession followed (courtesy of Ned Davis Research).  The recent string of economic data could force Washington and the Fed to address structural faults in the economy including the lack of savings and the reluctance on the part of corporations to invest. The economy is embroiled in a balance sheet recession/recovery caused by excessive debt accumulation.  Much of the weakness in the second quarter was the result of consumers paying down more than $50 billion in debt.  This occurred at a time when the government was transitioning from supplying stimulus to adopting austerity measures.  As a result it was of little surprise second quarter GDP estimates proved too high. The yield, last week, on the benchmark 10-year Treasury note fell to 1.97%, the lowest level in history.  Treasury yields reflect the weakness in the economy in addition to the likelihood that inflation pressures that had been driven by soaring commodity prices will slow.  We anticipate that the yield on the benchmark 10-year Treasury note will vacillate between 1.75% and 2.75% into next year.      

Sector Rankings and Recommendations

No.  1 Utilities = Thirst for yield – Marketweight/buy Groups expected to outperform:  Gas Utilities, Electric Producers

No. 2 Consumer Staples = Defensive sector gaining in RS – Marketweight/buy. Groups expected to outperform: Food Distributors, Food Retail, and Drug Retail

No.  3 Health Care = Improving RS – Marketweight/buy. Groups expected to outperform: Managed Health Care, Health Care Distributors, and Biotechnology

No. 4 Consumer Discretionary = Decelerating economy – Marketweight/hold. Groups expected to outperform: Automotive Retail, Home Furnishing Retail, and Apparel Accessories & Luxury Goods

No. 5 Information Technology = Improving RS – Marketweight/hold. Groups expected to outperform: IT Consulting & Services, Office Electronics

No. 6 Telecom Services = Defensive sector– Marketweight/buy. Group expected to outperform:  Wireless

No. 7 Energy = Losing RS - Marketweight/hold. Groups expected to outperform:  Oil & Gas Storage & Transportation, Oil & Gas Equipment & Services, and Integrated Oil & Gas

No. 8 Materials = Declining RS – Marketweight/hold - Groups expected to outperform: Industrial Gases, Specialty Chemicals, Paper Products

No. 9 Industrials = Sharp deterioration in RS – Marketweight/hold. Groups expected to outperform:  Railroads, Trading Companies & Distributors, Aerospace & Defense 

No. 10 Financials = Weakest sector – Marketweight/hold.

Market Overview

Stocks

Short-Term Trading range with risk to 1120 and reward to 1205 on the S&P 500

Intermediate-Term Trading range with risk to 1050 and reward to 1280 on the S&P 500

Long-Term Major support is 1000 on the S&P 500 and the reward is to 1365

 

Article provided by Robert W. Baird & Co. with the authorization of its author for Evan Guido, Vice President, Financial Advisor at the Sarasota office of Robert W. Baird & Co., member SIPC. The opinions expressed are subject to change, are not a complete analysis of every material fact and the information is not guaranteed to be accurate.

Evan R. Guido
Vice President of
Private Wealth Management

One Sarasota Tower, Suite 806
Two North Tamiami Trail
Sarasota, FL  34236-4702
941-906-2829 Direct Line
888 366-6603 Toll Free
941 366-6193 Fax

www.EVANGUIDO.com